LEGAL MATTERS: The Hidden Risks of Co-Signing a Loan
Wednesday, November 14, 2012
You may feel confident you can help a friend or family member pay off a loan by co-signing, but do you understand all the implications?
Your credit history is at stake
If the borrower faithfully makes every payment on the loan, the co-signer can be denied a loan under their own name because the co-signed loan is viewed as outstanding debt obligation by a potential creditor.
If the loan is not repaid in a timely fashion by the borrower, the co-signer can be liable for the loan plus additional amounts such as interest, late fees and collection costs, including attorneys’ fees.
GET THE LATEST BREAKING NEWS HERE -- SIGN UP FOR GOLOCAL FREE DAILY EBLASTFurthermore, the fact that the loan was not properly paid can lead to adverse information being made part of the co-signer’s credit report which can have all sorts of negative consequences.
The odds are against you
Not surprisingly, a substantial number of loans requiring co-signers go into default, afterall, commercial lenders require co-signers because -- in their opinion -- the borrower will likely default and it is a risk the lender does not want to take. In fact, the Federal Trade Commission estimates that of the loans that go into default, as many as three in four co-signers end up paying the bill in the end.
On at least two occasions, a stunned co-signer has contacted us seeking assistance after a creditor started billing them for the loan. In both these instances, the collateral that secured the loan had been destroyed. This often happens with cars. The borrower, due to financial issues, lets the insurance lapse on the car. The car is subsequently destroyed in an accident and there are payments left on the car. There is nothing for the lender to repossess and, even if the lender did, it would not cover the loan amount remaining on the car. The borrower now exacerbates matters by filing for bankruptcy.
Many co-signers conclude they have only one viable option -- pay off the loan after making sure the amount owed is legitimate. Any other option has serious credit consequences for the co-signer.
How best to protect yourself
If, after considering the substantial risks, you are inclined to assist the borrower, then consider structuring the transaction so that your financial exposure is fixed. One way to do this is to provide direct financial assistance to the borrower instead of co-signing for the loan. You can pay the full amount or you can loan enough for a substantial down payment. There are instances where a lender will forgo the need for a co-signer if a large enough down payment is made on the collateral. By loaning the money instead of co-signing, you have fixed the maximum amount you will lose should the borrower default.
Loaning the money directly also makes it crystal clear what is at risk. If the thought of not being paid back is unacceptable, then so is co-signing a loan. Ironically, every co-signer who has ever sought legal assistance from this firm has expressed a similar sentiment: “I never thought I would be held responsible to repay this loan.”
The foregoing is offered for informational purposes only and is not legal advice nor does it create an attorney-client relationship.
Susan G. Pegden is a litigation associate with the Law Firm of Hamel, Waxler, Allen & Collins in Providence. She is admitted to practice in Rhode Island and Massachusetts and is a member of the Board of Governors of the Rhode Island Association of Justice (RIAJ) and a member of the Rhode Island Women’s Bar Association.
Sean P. Feeney is a partner with the Law Firm of Hamel, Waxler, Allen & Collins. He is admitted to practice in Rhode Island, Illinois and Wisconsin. Mr. Feeney is a former special counsel to the City of Providence, military prosecutor with the United States Marine Corps and Special Assistant United States Attorney for the Central District of California.
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